Believe those who are seeking the truth. Doubt those who find it.Andre Gide

Friday, January 14, 2011

AIG Repays the Fed

New York Fed Ends AIG Assistance with Full Repayment
For release at 12:25 p.m. EST on January 14, 2011

NEW YORK – The Federal Reserve Bank of New York (“New York Fed”) today announced the termination of its assistance to American International Group, Inc. (“AIG”) and the full repayment of its loans to AIG as a result of the closing of the recapitalization that was announced on September 30, 2010. As of today, AIG will no longer have any outstanding obligations to the New York Fed.

Today’s closing represents a substantial step toward achieving the Federal Reserve’s dual goals of stabilizing AIG and ensuring its repayment of government assistance. It reflects the significant progress AIG has made in reducing the scope, risk and complexity of its operations and stabilizing its operating results. The accelerated repayment of the New York Fed frees up collateral that will enable the company to access private debt markets, an essential step toward facilitating the U.S. Department of the Treasury’s future sale of the common stock it owns.

"This concludes an important effort by the Federal Reserve to stabilize the financial system in order to protect the U.S. economy" said William C. Dudley, President of the New York Fed.

With today’s closing of the recapitalization, the New York Fed’s revolving credit facility has been fully repaid, including interest and fees, and its commitment to lend any further funds has been terminated ahead of the credit facility’s scheduled expiration in September 2013.

In addition, the New York Fed has been paid in full for its preferred interests in the AIA and ALICO special purpose vehicles. A portion of those interests has been redeemed with proceeds from AIG’s sale of ALICO to MetLife, Inc. The remaining interests have been purchased by AIG through a draw on the Treasury Department’s Series F preferred stock commitment and transferred to the Treasury Department.

The closing of AIG’s recapitalization also marks the termination of the AIG Credit Facility Trust, which was established to hold an approximately 79 percent controlling equity interest in AIG for the sole benefit of the U.S. Treasury, the general fund of the U.S. government. The Trust’s equity interest in AIG is being exchanged for common stock of AIG and transferred to the Treasury.

“We are grateful to Jill M. Considine, Chester B. Feldberg, Peter A. Langerman, and Douglas L. Foshee for their invaluable contributions and commitment to the execution of their responsibilities as Trustees,” Mr. Dudley added.

About the Federal Reserve’s actions related to AIG

In September 2008, the Board of Governors of the Federal Reserve System authorized the New York Fed to provide AIG with an emergency loan of up to $85 billion to prevent its disorderly collapse, which could have had catastrophic consequences to the U.S. economy during the most damaging financial crisis in 70 years. The assistance provided by the Federal Reserve was restructured over time, and was supplemented in November 2008 and April 2009 by additional financial assistance from the Treasury Department under the Troubled Asset Relief Program.

As part of the November 2008 restructuring of the government’s assistance to AIG, two special purpose vehicles, Maiden Lane II LLC and Maiden Lane III LLC, were created with loans from the New York Fed to purchase various mortgage-related securities in order to address AIG’s capital and liquidity strains. The loans extended by the New York Fed to the Maiden Lane II and III facilities remain outstanding and are being repaid from the assets in those facilities. The fair values of the portfolios well exceed the balances of those loans.

Yes, Prof. Accumulating total debt has followed a very nice exponential curve since the end of WWII. QE and friends are the natural conclusion.

I think, since we waited until QEs and bailouts were necessary, that QEs and bailouts were (at that point) necessary. It would have been nice to cap the growth of finance 30 or 40 years ago when things were less precarious.

AIA and ALICO were never the issue, these are good assets. Solid insurers. As for the balance of the loan, it's fortunate that it was paid off.

The most pressing issue regarding AIG's relationship with the Fed is Maiden Lane II and III. All of AIG's drek was offloaded from AIG into these 2 entities. Wait to see that these are recovered before rejoicing.

Prof J: Thanks for pointing out Plosser's speech. Reads like an argument in favouring of inflation targeting (or average price level targeting).

We know Andolfatto is in favour but he's a guest worker so nobody will listen to him. Nevertheless, I would guess that the whole cabal of Fed economists is in favour of inflation targeting. Surprisingly, nobody is seekng to purge these subversives from their office or employment. Fed economists must be even more impotent previously imagined.

And yes, I am not sure that the success of all this discretionary heroism bodes well for the USA and many other economies.

westslope: Nobody listens to me in my own country either! lol. And yes, I am in favor of an inflation-targeting regime for the US (abandoning the foolish dual mandate with one instrument idea).

Prof J: I like Plosser; and I liked his speech. Note, however, he does not criticize the Fed's role as lender of last resort; he simply labels it (incorrectly, in my view) as "fiscal policy." Collateralized lending is practically the definition of banking. Printing money and distributing it helicopter drop style is fiscal policy--but this is not what the Fed did.

JP Koning: Why are you so down on Maiden Lane? See here: http://www.ny.frb.org/markets/maidenlane.html#

In any case, this is only a tiny fraction of the Fed's portfolio.

What to make of this post? For crying out loud, people...ask yourself (honestly) what your reaction would have been if the Fed reported that it lost all of its investment in AIG.

I was impressed with Plosser moreso because of his comments regarding recalculation. I think we're in a second best world, (we have a central bank) and given that we have a central bank, there's certainly an argument for inflation targeting. Although that's not the only reasonable argument to make.

I personally wish there hadn't been any profit made. The fact that the positions have been profitable makes such acts likely again in the future. Moreover, it raises the expectation of bailouts, reducing the potential loss on and encouraging overly risky behavior. Essentially, the profit has encouraged moral hazard. I think it was a bad move all 'round, no matter the profit/loss consequences.

We don't disagree on many things, but I think this is one place where we might.

Yes, we live in a second-best world. But not because (as you suggest) we have a central bank.

We have a central bank because we live in a second-best world. Institutions are the response to the information and commitment problems that inflict efficient implementation of resources. The central bank can be viewed as a solution to this implementation problem in a second-best world.

Your concluding paragraph makes little sense to me. How do you define a "bailout?" I define it as a situation where (say) the Fed transfers purchasing power away from the broader citizenry to specific private interests. This is NOT what happened here! The Fed actually made a profit for the general citizenry on its activities. So how is this encouraging more bailouts?

I see where you are coming from here: "We have a central bank because we live in a second-best world."

The history of banking is replete with examples of the crown (and now the state) interfering in the banking system to finance its own endeavors. Historically, this was warfare. At any rate, this is what killed the Medici family. So the "second best" factor here, I would say, is the presence of the state and its separate interests from society. The exogeneity of the state might be a strong statement to some, and so that could be discussed further elsewhere.

Now, regarding your last paragraph, I think there are two separate factors that must be dealt with. One is the ex-ante declaration that non-Treasury assets will be purchased by the Fed. The second is the ex-post disclosure of profits.

I have to give this issue more thought. Right now I'm having difficulty separating bailouts from preventing monetary deflation in a realistic way.

David, I'm speculating here but I think that the 3 Maiden Lanes could one day represent one of the largest changes in the Federal Reserve's "portfolio allocation" powers since the 1930s. That was when Congress decreed that government bonds could finally serve as eligible collateral for Federal Reserve notes. If you follow the link behind my name towards my home page and on towards the historical chart of the Fed I created, you'll see what I mean when I say this change was dramatic (look at the rise in the blue part of the chart around 1934).

Unlike the 1934 change, the new powers that have been ushered in by the 3 Maiden Lanes were not the result of a democratic process. Congress was shutout. The Federal Reserve came up with a legal "hack" around the Federal Reserve Act in order to legitimate these new tools. If you want to know what this hack is you'll have to email me directly; I wrote about it for my firm and it's rather complex. To make a long story short, just as I have little trust in firms that find cheap tricks to skirt their own governing codes, I have little trust in the Fed for hacking theirs. So much for rule of law.

Yes, you are absolutely correct about the history of crown/state intervention in the business of money creation for the purpose of state finance. This is why the Fed wants to remain as independent as possible from Congressional pressure. People counter that the Fed is monetizing all sorts of debt; but all commonly employed measures of price inflation remain very low.

Moreover, if we replace the Fed with something else, this something else will necessarily be a creation of Congress (just like the Fed). You likely want Congress to legislate a gold standard. Fine. What's to prevent Congress from reneging on this when times get tough? Is it easier to dismantle an independent Fed, or abandon a gold standard?

JP Koning: I disagree with you. I'm pretty sure that section 13(3) of the FRA pretty much lets the Fed do whatever it feels is necessary in an emergency situation. There was not "shutout" of Congress. Congress expected the Fed to act quickly in such a situation--that's the whole purpose of 13(3).

Moreover, it's not like everyone in the Fed likes the powers of 13(3). As you read in Plosser's speech, he wants Congress to repeal that section.

These were not cheap tricks. This was the outcome of policymakers acting in real time during a period of dizzying turmoil. It is easy to play the Monday morning quarterback. But look...the Fed has basically done OK in my view...they did not lose money...they are trying to unwind these positions...it's not like the Fed is revelling in the power it exercised. In fact, quite the opposite.

Subscribe To

Favorite Quotations

"Believe those who are seeking the truth. Doubt those who find it." Andre Gide

The Democrats are the party that says government will make you smarter, taller, richer, and remove the crabgrass on your lawn. The Republicans are the party that says government doesn't work and then they get elected and prove it (P.J. O'Rourke)

But to manipulate men, to propel them toward goals which you – the social reformers – see, but they may not, is to deny their human essence, to treat them as objects without wills of their own, and therefore to degrade them (Isaiah Berlin)

I believe that sex is one of the most natural, wholesome things that money can buy (Steve Martin)

Nothing so needs reforming like other people's habits (Samuel Clemens)